When attempting to determine the cost of a project, it is important to understand the difference between accounting cost and economic cost. Accounting cost is a method used to calculate the total cost of a project that includes the tangible costs of goods and services. Economic cost, on the other hand, is the measure of all costs associated with the project, including the opportunity cost, or the cost of foregoing the use of resources. Accounting cost and economic cost are two different measures of cost and can provide different results for the same project. In this blog post, we’ll discuss the differences between accounting cost and economic cost and how each of them can be used to evaluate the cost of a project.
How to calculate accounting cost
You can total up all of your business expenses, such as the following, to determine accounting costs:
The formula for calculating accounting cost is:
(Costs of manufacturing) = (Costs of labor, salaries, and taxes) (Costs of facilities) (Costs of any other expenses)
For illustration, manufacturing costs $10,000 and labor and salaries $20,000
You can use the steps listed below to determine accounting costs:
1. Determine materials and manufacturing costs
The price of raw materials and the manufacturing costs necessary to turn the raw materials into your product will be some of your accounting costs. Electricity, property taxes, and insurance for the manufacturing equipment are examples of manufacturing overhead costs. The wages of manufacturers and workers on the production line will probably be included in this as well.
2. Calculate labor, salaries and taxes
Include the wages of all employees in addition to those paid to those working in manufacturing. You can determine your overall accounting costs by calculating your total payroll expenses. In addition to payroll, take into account any payroll taxes and potential fees to determine the overall costs of paying your employees.
3. Determine costs for the facility
You can proceed to the facility costs once you’ve determined all of your labor costs and employee salaries. Rent or mortgage payments may represent a significant business expense. When calculating your accounting expense, take into account the cost of rent, insurance, and utilities.
4. Define any additional costs
It will be easier to ensure that you’re calculating your total accounting costs if you include any additional expenses. Additional expenses may include marketing and advertising or office supplies. It’s critical to include all business expenses when calculating your accounting costs because the objective is to know exactly how much you’re spending or anticipate spending.
5. Add all accounting expenses
You should total up all of your business expenses, including manufacturing, payroll, rent, and any other recurring costs, in order to determine your accounting cost. For instance, if you project a profit of $100,000 and projected costs of $45,000, including employee salaries, rent, insurance, utilities, office supplies, and other costs, your accounting profit would be $55,000 and your accounting costs would be $45,000.
What are accounting costs?
Payroll, production costs, and marketing budgets are examples of accounting costs, which are explicit costs also known as “hard costs.” Due to the fact that explicit costs include specific dollar amounts, businesses can easily track them. Anything your company actually spends is considered an accounting cost, and you deduct it from revenues during a given accounting period. This means that your expenses for marketing, producing, and delivering your goods are real money that leaves the bank each accounting period. Prior to calculating your accounting profit, you must first determine your accounting costs.
For instance, if a company intends to open a storefront in a new market, they may first choose to invest in things like hiring new staff, purchasing new computer software and equipment, increasing their product inventory, and paying for rent. The total accounting expense will be $40000 if all of these features were purchased.
Additional examples of accounting costs may include:
What are economic costs?
Accounting costs and implicit costs, which are fictitious outlays used to project potential profits when making business decisions, are both considered economic costs. This means that both explicit and implicit costs are included in economic costs. When making financial projections or choosing the best course of action, such as reallocating funds or switching to a more efficient mode of production, accountants and business leaders consider economic costs. Accounting professionals can consider both the actual accounting costs and the speculative costs of a potential business decision using economic costs.
Economic costs are crucial for businesses because they aid in the formulation of long-term strategies and serve to summarize the current and future worth of the organization. Business leaders can make decisions about which markets to enter or leave using these economic costs, and they can reassure investors that their company has genuine, long-term value. Economic cost analysis has the advantage of revealing the cost differences between various business options. For instance, if a company has determined that it will cost $400,000 to open a storefront in a new market, accounting costs may allow them to take into account:
How to calculate economic costs
By comparing alternative costs to the accounting cost, calculating an economic cost can assist you in choosing which strategic option to pursue. Take the total accounting costs and add or subtract the cost in money of selecting a different course of action to arrive at the economic costs. Here are some steps to calculate economic costs:
1. Calculate the accounting costs
Find the total amount of expenses you currently have using the formula for calculating accounting costs. Consider all aspects of design, labor, manufacturing, production and distribution. You can compare your current spending to the amount of profit you are making by adding up all of your business expenses.
2. Calculate your implicit costs
Once you’ve determined your explicit costs, you can determine your implicit costs or the costs that would result from choosing a different course of action. Perhaps in a different scenario, you would only need three store managers rather than six, which would have an impact on your overall labor costs. Alternately, the business option you’re thinking about might involve entering a new market. In that case, you can total up all potential costs and investments associated with this process.
3. Subtract implicit costs from explicit costs
You can determine your economic cost in order to decide which business option is best. Subtract your anticipated implicit costs from your predetermined accounting cost to arrive at your economic cost. This calculation can help you decide whether to pursue an alternative business venture by showing whether a different course of action might result in financial savings for your company.
When to use accounting costs vs. economic costs
Although both are useful for understanding your company’s financial situation, you may use accounting costs and economic costs at various times. An economic cost weighs the potential differences between one action and another, whereas accounting costs measure the monetary value of an action, such as payroll or utilities. When calculating your overall expenses and comparing them to your overall gross profit, you can use accounting costs. Understanding your accounting costs will help you determine how much you spend compared to how much money you make.
You can use economic costs to assess whether a different course of action will result in a greater profit or reduce spending in specific areas. When choosing between two alternative business strategies, you can compare economic costs to help you decide which option is best for the company. You can get a more complete financial picture by considering alternative options rather than just the accounting cost.
Episode 21: Accounting Costs vs. Economic Costs
FAQ
Is accounting cost greater than economic cost?
Also, economic costs are ALWAYS higher than accounting costs. Accounting costs PLUS implicit costs, or opportunity costs, are considered economic costs. There is always an opportunity cost because you could spend your time or money in another way.
What is the difference between economic costs and accounting costs quizlet?
Due to the fact that economic costs include all opportunity costs and accounting costs only include explicit costs, economic costs are typically higher than accounting costs.
What is the difference between accounting and economics?
Accounting and economics both involve plenty of number-crunching. But while economics is a field of the social sciences that focuses on the production, consumption, and transfer of resources, accounting is a profession dedicated to documenting, analyzing, and reporting income and expenses.
What is an example of economic cost?
The explicit and implicit costs of an action are both considered to be economic costs. Another illustration is if a business owns an asset, such as an orange grove, and uses an economic cost analysis to assess whether it would be more advantageous to maintain and harvest the orange grove itself or to lease it to another business to handle the task.
